What is the Effect of Interest Rate Hikes?

We all hear of the United States and Canada starting to increase the Interest Rate slowly but so far it has been twice and possibly another one this fall or by end of year.  I recently read an article from Nasdaq indicating that for Canada in particular there is a possibility of once more rate hike due to the strong economic growth in line with the International Monetary Fund’s (IMF) forecast.  The latest report from the Globe and Mail (July 24, 2017), one of Canada’s newspapers mentions that Canada leads G7 in economic growth as per the IMF.  All these are reports, research and statistics are positive and great for Canada; however, one cannot take that into factor as there are other issues that Canada is dealing with.  One is the housing market, the second is the average household debt and the last but most important is the negotiations going on between Canada, U.S. and Mexico with regards to the North American Free Trade Agreement (NAFTA).  Things do not look good with regards to the outlook from the meetings from the leaders and foreign ministers from the 3 countries.

Canada is introducing new mortgage rules which will take effect January 1, 2018 to tighten the lending from borrowers and home buyers will need to put 20% or more with regards to down payment; as well, there will be a stress test to see if the home buyers are able to handle an interest rate hike of an extra 2%.  Overall, this is a smart decision to reduce the high costs of borrowing and home buyers will either have to wait to purchase a home or go with purchasing a home that is more affordable.  The purpose is to stabilize the housing market and reduce the bubble.  Will this work?  Note that home buyers are not only Canadian but also foreigners.  It would make sense that this would work nationally throughout Canada but one has to see if there are loopholes that home buyers can take advantage of.  The only thing is to wait and see once the new rules take effect.

What is the effect of interest rake hikes with regards to household debt?  A higher interest rate will affect the amount of debt payment from lines of credit, mortgages, any debt where there is a prime lending rate.  The number of delinquencies will surely rise and will just make the it worse for families trying to pay off their debts.  On the other hand of leaving interest rates low, it still attracts one to borrow.  The problem is living over the means of one’s budget and household income.  It will not matter if interests rate stay low or go up until we as a society understand the value of the monetary system and work within our limits.  There will always be consumerism and the consumer needs to start looking below the threshold of their spending.  The target is to live within our means and better yet to live below our means.  Spending habits have to be changed and controlled in order to bring about an ideology to counter our struggle with debt.    We have to focus on what we need to survive and that is food, clothing and shelter.  As soon as we live where money works for us and not the other way around, we will then be able to put it to use on the important things in life.  I am not saying that we do not spend on things we like but to act responsibly and purchase items that will be of use in the now and in the future to come.

The economy is great, jobs have been created but now we face uncertain times especially those living in Canada and Mexico.  The Trump administration in the United States is now targeting the NAFTA which has been in place for over 30 years.  There have been many meetings between the 3 countries but the United States is demanding a re-negotiation of NAFTA or end it all together.  From hearing the news and radio, there are already disagreements and there is a feeling that the demands brought upon by the United States presently is telling that if it fails, let it fail.  What will be the repercussions if NAFTA fails?  There will be introductions to tariffs between the countries; some will be high; some will be moderate.  The times of a growing and healthy economy will not last forever.  It can turn the tide and possibly lead to a recession or it will benefit one or all three countries.  I cannot predict the future and I don’t know what will happen but for certain it will increase competition.  There will be job losses and job increases; it all depends on which country benefits when NAFTA is no longer.  The question we have to ask ourselves is do we need this?  Where will this lead us?  What are the alternatives?  I could be all wrong and nothing will happen, NAFTA will be intact.  We have to be prepared for the outcome anyway; with interest rate hikes or not.

I would love to hear from you and get your perspective with regards to interest rates and whether it will be for the better or worse.  Given the circumstances from this article, what position will interest rates take in terms of stability and the global outlook?

4 thoughts on “What is the Effect of Interest Rate Hikes?”

  1. Interesting article. As a wealth advisor in the U.S. (yes, I run a martial arts website, but investments and economics are my full-time job), I have seen the effects of interest rate changes on many aspects of people’s lives. In terms of markets, it has driven stocks to all-time highs as people look for investments that give them some sort of yield since bonds do not pay well (which is not good for those with short time horizons and don’t have time to recover should markets correct – they NEED bonds for protection). From the standpoint of corporate earnings, it has led to an increase as companies can restructure debt at low cost and clean up their balance sheets, lowering their liability burdens. From a consumer standpoint, it all depends. It’s been great for mortgage borrowers and debtors who have been able to pay things off, but it’s been terrible for those on a fixed income and are getting low rates on their investments (or Social Security, where COLAs have been scarce and small). Rising rates will have both a positive and negative effect, depending on whether you’re paying or earning. For home buyers, it may be a little harder, but as the economy normalizes (supposing rates are raised gradually), this should lead to a healthier economy overall as fixed income instruments are used more in personal portfolios as they should be and as our financial systems strengthen and become more stable.

    1. Hello Steve,

      Thank you for your providing your knowledge and opinion with regards to the economy, bonds, and how interest rates affect both the corporate and consumer. I agree that those that are dependent on bonds will not fare well with the low interest rate and the need for the rate to increase is necessary in the foreseen term. The markets (specifically the U.S.) is breaking all time records with the Dow Jones Industrial average; but, how long will this last? If there will be correction, will it be a big correction based on the length of the bull cycle or just a brief dip (i.e 20% correction), flattening and recovery? The other problem that society is facing is household debt and all this is because of the rock bottom interest rate. The problem will be for those that have not saved for themselves and their retirement. As the interest rate rises, how will one be able to stay on top of their finances? Will there be an age of a bankrupt and delinquent society? Will the governments or World bank need to intervene if it goes out of control? Have not previous civilizations collapsed because of this sort of problem? I know that there are solutions to problems, markets correct, it is cyclical. Will we now say that we have to face reality and include debt as a cyclical entity? I am sure there is someone out there who will come up with a new system to tackle debt.

  2. For the past fifteen years I have purchased distressed properties and sold them, usually for two or three times what I paid for them. When you buy properties at a discount, you don’t have to be an expert on interest rates, but you still need to know what is going on around you. Thank you for the interesting article that you wrote… I learned several things I didn’t know, and that is always a good thing when you deal in real estate
    .
    Clay

    1. Hello Clay,

      Interest Rate hikes makes a big difference when it comes to purchasing properties as the payments and the amortization will increase.  Unless one has the means to add more to the payment to keep in line with paying off the mortgage, it can make situations difficult.  Now when I hear the news in Canada, the Bank of Canada is now thinking twice about raising rates with the rising household debt, continued uncertainty with the NAFTA and now  the future growth of the economy.  The last thing a country would want is a bubble burst as the after effects can be catastrophic.

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